WASHINGTON (Reuters) — A growing number of
Americans quitting the labor force are likely gone for good, offering a
cautionary note to the Federal Reserve as it tries to gauge how tight
the jobs market is and how quickly to raise interest rates.

For a long time, data suggested a significant portion of the
decrease in labor force participation was because many job seekers
had grown frustrated with their search and had given up looking. If
the job market tightened enough, the thinking went, these Americans
would be lured back to hunt for work again.

But a different picture is now emerging. Data shows participation in
the past few years has fallen mainly because Americans have retired
or signed up for disability benefits.

"The data suggest that the recent exits from the labor force have
been more voluntary in nature than was the case in 2009, when the
economy was weak and job prospects were dire," said Omair Sharif,
senior economist at RBS in Stamford, Connecticut.

According to economists who have analyzed Labor Department data, 6.6
million people exited the workforce from 2010 and 2013. About 61
percent of these dropouts were retirees, more than double the
previous three years' share.

People dropping out because of disability accounted for 28 percent,
also up significantly from 2007-2010. Of those remaining, 7 percent
were heading to school, while the other 4 percent left for other
reasons.

In contrast, between 2007 and 2010, retirees made up a quarter of
the six million people who left the labor force, while 18 percent
were classified as disabled. About 57 percent were either in school
or otherwise on the sidelines.

"This suggests the current drop in the labor force is more
structural in nature," said Sharif.

If so, there is less hope of luring people back to hunt for work as
the jobs market tightens, as many Fed officials believed would be
the case. And the U.S. central bank, which has held benchmark rates
near zero since December 2008, will likely need to push them up
sooner than they would have otherwise.

"It is not clear whether the overall participation rate will
increase anytime soon, given that the underlying downward trend due
to retirements is likely to continue," said Shigeru Fujita, an
economist at the Federal Reserve Bank of Philadelphia.

LESS LABOR MARKET SLACK

Some Fed policymakers, such as San Francisco Fed President John
Williams, are starting to acknowledge that structural factors are
playing a big role in the labor force's decline.

In a speech last month, Williams said the slack in the labor market
could be "much less than assumed," cautioning that inflation could
rise more quickly than currently anticipated.

There are people who are not in the labor force who say they want a
job and who could potentially be drawn back in.

Last year that figure stood about 700,000 higher than it would in a
normal market, according to the Labor Department's survey of
households. But if employment increased by about 115,000 jobs per
month, as the survey found it did last year, they could easily be
absorbed in about six months.

The disappearing slack is underscored by a sharp decline in the
ranks of the short-term unemployed.

These workers, whose skills
are still sharp, are viewed as the most desirable by employers,
economists say. Further, they appear to hunt for work more
aggressively, according to a study released last week by former
White House economist Alan Krueger.

In contrast, long-term unemployed can see their skills erode and lose contact with people who could help them find a job.

Because employers find them less desirable, their presence in the
labor market may not do much to keep wages down.

The unemployment rate for people out of work for six months or less
was at 4.2 percent in February, well below its 5.2 percent
post-recession average. The number of short-term unemployed workers
is now at about the same level as in 2004.

As for the long-term jobless, their ranks are still more than double
their 2004 level.

Some economists say the dwindling pool of attractive workers may
already be leading employers to bid wages up. Average hourly
earnings for production and nonsupervisory workers notched their
biggest gain in four years in February, even as some broader
measures showed little acceleration.

"With the short-term unemployment rate already back to its
pre-crisis level, any further declines will put upward pressure on
wages and ultimately inflation," said Torsten Slok, chief
international economist at Deutsche Bank Securities in New York.

"For the Fed, the problem is we are still having a fed funds rate
which is zero. I think the Fed will start to change its tone, most
likely in the second half of this year."

(Reporting by Lucia Mutikani; editing by Tim Ahmann and James
Dalgleish)